Weighted Average Cost of Capital - WACC

Weighted Average Cost of Capital - WACC

A calculation of a firm's cost of capital that weights each category of capital proportionately. Included in the WACC calculation are all capital sources, including common stock, preferred stock, bonds, and any other long-term debt.

WACC is calculated by multiplying the cost of each capital component by its proportional weighting and then summing:





Where:
Re = cost of equity
Rd = cost of debt
E = the market value of the firm's equity
D = the market value of the firm's debt
V = E + D
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = the corporate tax rate

Notes:

Broadly speaking, the assets of a company are financed by either debt or equity. WACC is the average of the cost of each of these sources of financing weighted by their respective usage in the given situation. By taking a weighted average, we can see how much interest the company has to pay for every dollar it borrows.

A firm's WACC is the overall required return on the firm as a whole. It is the appropriate discount rate to use for cash flows similar in risk to the overall firm.

See also: Cost of Capital, Cost of Equity, Debt, Discount Rate, Equity, Market Value